Vanguard Utilities (VPU) ETF: A New Era of Clean Energy | Whuff News


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As you know, going through bear markets is an especially pleasant experience for investors who have built a well-diversified portfolio that includes allocations to defensive sectors such as consumer staples, health care, and financials—all of which tend to outperform the broader. The S&P 500 is at times of high inflation and rising interest rates. Another important hedging sector is utilities, which provide decent income and tend to outperform in times of market stress. I Vanguard Utilities ETF (NYSEARCA:VPU) is down ~10% since its debut in early September (see below), and is a fund that investors should consider to gain exposure to the utility sector. Long-term, the VPU ETF appears well-positioned for the clean-energy transition and renewable energy years. Today, I’m going to take a closer look at the VPU ETF to see if it’s a good addition to your portfolio.

Chart
Data is YCharts

Investment Thesis

It’s no secret that the world’s power grid is being restructured to get more energy from renewables (solar, wind, and battery storage) to address the ever-present threat of global warming. At the same time, the transition to EVs will require more electricity. Utility companies are clearly at the center of this massive shift, and stand as beneficiaries of the Biden administration’s passage of the bi-partisan Infrastructure Act. The legislation includes more than $65 billion — the largest in U.S. history — in investments in clean energy transmission and the electric power grid. This Act will fund new programs to support the development and deployment of advanced clean technologies to accelerate the transition to a clean economy.

With that background, let’s take a look at the Vanguard Utilities ETF to see how it positions investors for success going forward.

Top-10 Holdings

The top-10 holdings of the VPU ETF are shown below and are taken directly from the Vanguard VPU homepage. The top-10 holdings are equivalent to what I think is 53% of the 65 company portfolio:

VPU ETF Top-10 Holdings

Vanguard

#1 holding a weight of 13.9% is the largest utility company in America: NextEra Energy (NEE). NextEra became the most profitable company in the US by being a strong adopter of wind, solar power, and natural gas while its coal-centric peers were slow to realize the potential costs of clean energy. Others, like #3 catch Southern Company (SO), even turned to large-scale “clean coal” (an oxymoron if ever there was one…) projects with predictable and disastrous results (see Verdict: Natural Gas Blames ‘Clean Coal’).

NextEra owns Florida Power & Light (“FP&L”) and a clean energy business – NextEra Energy Resources, LLC – which owns renewable energy generation assets in an MLP – NextEra Energy Partners (NEP). With these subsidiaries, NextEra is “the world’s largest generator of renewable energy from wind and solar and the world’s leader in battery storage” (see the slide below, and more information on NEE in this latest investment statement). In addition, NextEra Energy produces clean, zero-emissions electricity at seven nuclear plants in Florida, New Hampshire and Wisconsin.

NextEra's Clean Energy Portfolio

NextEra

Since 2006, NextEra has grown its dividend at a CAGR of 9.8%, and its stock price at a CAGR of 8.4%. That said, NEE has delivered exceptional returns to investors over the past decade, more than double the broader S&P500 (not bad for a utility company):

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Data is YCharts

The power of Sempra (SRE) is #5 holding a weight of 4.3%. Sempra is one of the largest companies in North America, with energy networks and investments in California, Texas and Mexico. Sempra is set to build a new LNG export plant in Port Arthur, TX. The company’s Q3 report was solid on both the top and bottom lines. The stock is up 27% over the past year and yields 2.88%.

The #6 catch is American Electric Power (AEP). AEP Corp. owns 40,000 miles of electric power transmission lines – the largest system in the US The company has 26 GW of electric power generation capacity and 5.5 million customers in 11 countries. Unfortunately, 40% of AEP’s power generation comes from high cost and dirty coal. AEP stock is up 11% over the past 12 months and has yielded 3.56%.

The #9 catch is Integrated Edison (ED) with a weight of 2.85%. ConEd delivered a $0.17 hit in Q3 and the stock is up 20% over the past year and yielded 3.36%. Last month, ConEd announced it would sell its Clean Energy business to a German company RWE (OTCPK: RWEOY) in a transaction valued at $6.8 billion.

Overall, VPU’s portfolio is mainly represented by utilities (60%) and companies focused on utilities (26.6%), with smaller allocations to gas and water:

Active Sector Exposure

Vanguard

As you can see, the share of renewable electricity “to play” in VPU is listed as only 1.5%, but that is misleading considering almost every company of “Active Electricity” is now investing heavily in renewable energy. Indeed, the EIA reports that the majority of new electricity in the US this year again (as in the past few years…) comes from solar and wind (63%). Battery capacity additions are expected to be 5.1 GW, or ~11% of additional new capacity:

2022 additions to the Generation of Power

EIA

To work

As mentioned in the bulletins, VPU has an impressive 10-year return of 9.86%:

Performance of the VPY ETF

Vanguard

The following chart compares VPU’s 3-year total return versus its peers: i SPDR Utilities ETF (XLU), and Fidelity MSCI Utilities Index ETF (FUTY):

Chart
Data is YCharts

As can be seen from the graph, the XLU ETF is the leader of the pack. Like VPU, XLU also has an expense ratio of 0.10% but a much larger share of NEE (16.43%). XLU has a TTM yield of 3.04%.

Appreciation

The chart below shows some metrics comparing VPU against its competitor – XLU:

P/E Price-to-Book TTM Yield
VPU 19.7x 2.1x 2.94%
XLU 22.4x 2.15x 3.04%

As you can see, despite XLU’s high P/E ratio, the funds are very similar. XLU’s high valuation is likely due – at least in part – to its large allocation to NEE (P/E 43.7x). However, that is probably why XLU outperformed VPU by ~1.8% in the last 3 years and 0.5% in the previous year.

Risks

While the risks of investing in the Active Sector are generally lower compared to the broader S&P500, the sector is not immune to the investment macro-environment. High inflation and high interest rates can lead to a weak economy which can result in low demand for electricity from consumers and industry. That could put downward pressure on earnings, dividend growth, and ultimately stock prices.

Additional risks include a faster-than-expected transition to EVs and therefore greater demand for electricity and higher profits for utility companies.

Summary and conclusion

With the transition to renewable energy production now in flux, the Sustainable Energy Sector has been excited in my opinion. New opportunities in wind, solar power, and battery storage — combined with a big tailwind from the government’s Infrastructure Act and EV revolution — mean that electricity generation and transmission companies have a bright and growing future that could increase rapidly in the coming years. However, the VPU ETF appears to be fully valued at this time, so I rate it a HOLD. In the meantime, investors considering an allocation to utilities should also consider the XLU ETF, which I consider to be better than VPU because of its large allocation to a company that operates in the US: NextEra Energy. Investors should also be patient and consider using current market volatility to weigh in on lower entry points. For example, VPU at, say, ~$145 and XLU at ~$65. After all, the utility sector is now trading in the near market, when it traditionally trades at a very low price.

I’ll conclude with a 10-year return comparing VPU versus XLU and note that their returns are similar:

Chart
Data is YCharts



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